What Is A Risk To Reward Ratio?

What Is A Risk To Reward Ratio?

A risk to reward ratio in Forex trading is how much you are betting compared to what you expect to make from any one particular trade.

If there was one thing I wish I took the time to understand better when I started out on my trading journey, it would be the importance of a good risk to reward on every trade.

For the longest time, I thought there were only 2 main aspects to trading, Technical analysis, and Fundamental analysis.

Any trader worth their salt can quickly see the issue with this way of thinking.

None of those aspects involve Risk Management. Easily the most important aspect of profitable trading.

Simply Put

Risk to reward ratio is your potential loss on a trade versus your potential gain on a trade.

You will hear experienced traders talk about this a lot more than any technical or fundamental views they have on the Forex market.

I don’t want to give new traders the wrong idea of what I’m about to say next, but Simply put, if you fail to understand how to trade with a good risk to reward on every trade, you have a 95% chance of being a consistently UNPROFITABLE trader.

5% is for traders who have found a way to be right more than 80% of the time in the Forex markets. Read more on win percentages here.

That is the more complicated way to go about being a profitable trader. The easier easy to become consistently profitable is to have a good risk to reward ratio.

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An example of how you would write down a risk to reward ratio is this; you identify a setup in the Forex market, determine where your stop-loss would be (say 20 pips), and you reckon price could move about 60 pips in your favor from your entry price.

Potential loss of 20 pips and a potential gain of 60 pips is a risk to reward ratio of “1:3”.  If your risk is “1”, then your potential gain is 3 times bigger than your risk, ergo “1:3”.

If you can wrap your head around why it is vital to have a good risk to reward ratio, you are miles ahead of your newbie counterparts.

Newbie traders sometimes even have a NEGATIVE risk to reward.

A negative risk to reward looks like this; If you determine your stop-loss (20 pips again) and a potential target of 10 pips that the market could move in your favor, that is a risk to reward of “2:1”.

In the above example, your risk could be written as 1 because it was smaller than your potential gain. The smaller number will always be “1,” so you can compare the two accurately in a ratio form.

A negative risk to reward makes your job as a trader almost impossible. Don’t listen to people that tell you differently.

You could have a win rate of 80% and still lose money if you have a negative risk to reward, which is what casinos do.

They pay you less than you risk when you win, so mathematically, you will always lose in the long run.

You might win once or twice with a negative risk to reward, it might even help you stay in trades longer, but it won’t matter because, after 50 trades, you will be broke.

Work at carving a good risk-to-reward out of the Forex market.

What Is a Good Risk to Reward?

A lot of material online will tell you a risk to reward of 1:3 is a good balance, but if I’m honest with you, I will implore you to try and aim for 1:4 and above in your trading.

1:3 is good enough to make you a profitable trader, yes, but it certainly won’t make you a rich trader, which is why you probably got into Forex in the first place, right? To make BANK.

So if you want to show off to your friends and family only that you could become slightly profitable in a world where 90% lose money, then sure trade 1:3, but if you want the life you have in your mind, A risk to reward of 1:4 minimum should be your goal.

The truth is your targets won’t always be met, and you want to give yourself room to close a trade prematurely without making the trade useless.

A risk to reward of 1:4 minimum affords you that. If you can bag a couple of 1:6s or 1:10s once or twice in a month, it won’t really matter what your win percentage is.

DON’T GET ME WRONG. You still need to win a good number of your trades but in the long run… You win.

Don’t bet the farm.

Don’t lose your shirt.

Cut the L.

Keep the W.

Happy Trading.

Risk to Reward FAQ

A risk to reward ratio in Forex trading is how much you are betting compared to what you expect to make from any one particular trade.

A lot of material online will tell you a risk to reward of 1:3 is a good balance, but if I’m honest with you, I will implore you to try and aim for 1:4 and above in your trading.

1-2% per position is a good guideline, but don’t go over. With a $10000 trading account, this would mean a max risk of $200 per trade. With a $50000 trading account, this would mean a max risk of $1000 per trade.

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Lunga Shabangu

Lunga Shabangu

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